Archive for the ‘Economics’ Category

Times are hard, our politicians have (with the collusion of the electorate) made a right mess of things and huge numbers of people across the UK and Europe have seen their real income falling. Our leaders are exhorting the people to make sacrifices for the good of the nation, so I think it might be time to take a look at their remuneration. Fair is fair after all.

A voter pays an MP yesterday.

Performance related pay has become widely prevalent in the private sector. If you’re good at your job then you get more money, be it in bonuses or other benefits. The important point is that your incentives are more closely aligned with those of your employer. Everyone wins. Well, except the people who are bad at their job… MPs on the other hand have a fixed salary, the only risk they face is losing their seat and hence their job. Unfortunately the link is not all that strong. The Electoral Reform Society estimated that approximately 60% of the House of Commons’ seats were safe. Many of the others would only change hands in exceptional elections. For the majority of MPs, there is little to fear from voters.

I think the current level of pay for UK MPs (just over £65,000 p.a.) is about right. However, up until recently it was MPs that set their own salary, and there is still no link with their performance. The US Congress has an interesting system for trying to deal with the issue. Basically, any pay rise that its members give themselves only comes into effect after the next election. In my opinion, that’s a nice idea, but in the end representatives’ pay will (and probably should) be subordinated to other issues when voters make their choices.

So, I propose linking MPs pay to a weighted average of changes in the nation’s incomes. Each year their pay would be revised up or down based on the percentage change in the average income of each tenth of the population. If the top tenth had their income increase by 20%, MPs’ pay would also increase. However, it would not increase by 20% unless everyone’s income went up by that much. Instead, assuming no one else’s income increased it would only go up by 2% (10% of the population, 20% increase, 10% of 20% is 2%). If everyone’s income increased by 20% then it would go up by 20%, if only half the population had an income increase then it would go up by half of whatever their average increase was.

This encourages the government to support growth, but it also encourages it to support growth that benefits the population as a whole. This is because, assuming the same amount of economic growth, the more it is concentrated in the hands of the wealthy, the smaller it will be as a percentage of income for the people it benefits. If the economy is £100b richer, and all the gains go to the rich, it might only give the richest 10% a 1% increase in their incomes. If all of that money went to the poorest 10% it might be 100% of their incomes. So, for the same increase in absolute terms the politicians’ pay would go up considerably more if the money went to the poor.

The last 10-20 years have seen significant economic growth, but much of that growth has gone to the richest part of society. My proposition aims to incentivise economic growth but also a more equitable distribution of it. The rich have plenty of tools for influencing public policy to their advantage, equally attempts at massive wealth redistribution would be likely to hurt growth. For MPs to get their pay increases they need economic growth, my way just aims to ensure that that growth is shared round a bit more.

Of course there are some weaknesses to this proposal. Firstly, it might over-emphasise economic growth as a tool of government policy. I accept this is a possibility and there are plenty of other goals which should be pursued, however, I do think that economic growth remains the best method of improving people’s living standards as long as it can be fairly distributed. It also provides a far more transparent method of assessment than most other policy goals could.

There is also has the problem that it might not actually be a significant incentive. If MPs get most of their income from other sources, then they are unlikely to care much whether they get a 1% or a 3% pay rise. Unfortunately I don’t have any statistics on MPs’ extra earnings, but from my own political experience and knowledge my impression is that most backbenchers do in fact rely on their pay. Ministers may be a different matter – even if they have few extra earnings during their tenure, they often have significant opportunities to earn after they resign. For an extreme example look no furtherthanTonyBlair. In the end, I think some incentive is better than no incentive, and people like Tony Blair are certainly not the norm.

Finally, there is a risk of short termism. The current debt crisis is a good example of the problems with politicians ignoring sustainability in favour of immediate growth. If you can boost incomes significantly with government borrowing then you can effectively mortgage the country’s future in order to get a pay rise now. Of course these arguments could also be applied to having elections on a regular basis. What I would say is that there is a very high incumbency rate in the UK which gives MPs an incentive to think in the long term. In this case my pay scheme could actually work better than elections for long term thinking. If most MPs know that they will probably be in their position for a long time, it doesn’t matter whether they’re part of the government or not; if they leave the other party a heap of shit to deal with, their pay is still going to drop.

So, all in all, I think the idea could work. Bringing a bit of private sector style incentivisation to our legislature would do it good and it would be nice if the proceeds of growth could be shared a little more evenly. If you see any holes in what I’m proposing, please do feel free to criticise.

*It’s worth noting that MPs do also get very good pension rights, amongst other things, which makes the remuneration more attractive than the base figure would suggest.

The eurozone crisis should be depressing anyone who even half-heartedly follows business news. The contagion is spreading rapidly, even core countries such as France and the Netherlands are seeing their debt yields rising. If Italy does go over the edge we can prepare ourselves for a full on depression.

Credit for the Image to 'africa'

So, here are three pieces of good news. They don’t outweigh the general doom and gloom surrounding the European (and by extension the world) economy, but they do provide glimmers of light at the end of the tunnel. Without further ado:

1) If the eurozone can survive the next year or two it will be in an excellent competitive position. According to a study from the Lisbon Council, a Brussels based think tank, reforms of the major European economies is much further along than the popular perception, and the economic and competitive convergence needed to successfully run a single currency are also taking place. They have harsh words for France, which appears to be reforming as little as the Germans but without their strong economy, but the PIIGS are said to be rapidly improving their situation.

2) Portugal is meeting its targets and Ireland’s GDP has started to grow again. Today the ‘troika’* announced that they were very satisfied with Portugals progress and that it was successfully meeting its targets under the bailout deal. Similarly Ireland’s GDP has grown in the last two quarters.

3) Italy has never defaulted on a debt in peace time. As this Telegraph article explains, Italy’s only debt default in its whole history was on debts owed to the Allies in 1940. I don’t much approve of people defaulting on debts they owe to us, but when we’re actually at war it’s probably excusable. This contrasts with France and the UK which defaulted in 1932 and 1933 respectively. Italian default is the greatest danger to the European economy, and so if you have reason to think they don’t do default it’s a reason to be more optimistic.

Realistically there are plenty of reasons to feel down about the European economy, and my own view is that it has a pretty negative outlook. But hey, writing this post at least made me feel better for a bit.

When I started writing this my flatmate asked me, “are you going to be writing about the boring kind or the good kind?” Luckily this post is all about the ‘good’ kind of pirate. I have nothing but respect for the ceaseless struggle of copyright holders. Endeavouring to protect us from the horrors of spotty teenagers torrenting their products, but let’s face it: desperate men with AK 47s are much more exciting.

The coolest kind of pirates.

Somali pirates have repeatedly made the for hijacking various ships and holding them and their crews to ransom. Of course the ransom money is not actually the main cost of piracy. You also have to take into account higher insurance premiums, less efficient routing of ships and the deployment of naval assets. Altogether, the cost of Somali piracy was estimated at around $10 billion in 2010. That’s more than one Macedonia or roughly 1/16th of an NHS.

This is a huge amount of money and it’s set to increase. So, what should be done about it? Unfortunately Somalia is a failed state where there are virtually no opportunities available to people to make an honest living. Crime is rife, warlords rove, European fishing vessels deplete their stocks and there is the occasional foreign invasion. Given the difficulty of even eking out a living as a subsistence farmer is it any surprise that many Somalians are keen on becoming pirates? It’s risky, sure, but life is cheap over there and the potential rewards are very high.

I see three ways of solving the problem. Firstly we could try to build up a government which could then clamp down on piracy and bring stability. Basically use our wallets and/or military might to turn Somalia from an anarchic shithole into a functioning state. Unfortunately we’re not very good at this kind of thing. The war in Afghanistan has cost the US alone over $400 billion so far and I’m pretty sceptical about the country’s prospects once the US withdraws. The Somali government barely controls any land outside the capital and is in the middle of a civil war with the Islamic Al-Shabaab group. Basically we have a choice between ruling the place ourselves, backing a nutty Islamist group or backing a government that doesn’t deserve the name. None of those sound like particularly viable options to me. So, a superficially attractive option but not one we could actually pull off.

I suppose military force is also a possibility. We have lots of warships, the Somali pirates don’t. It would be pretty easy to simply sail along the coast blowing places up until they stopped bothering our ships. The simplicity of this approach is kind of attractive. Those who live by the sword die by the sword etc. Unfortunately I have some moral qualms about mass murder as a response to piracy. It feels like the kind of solution that was only morally acceptable in the 18th century and I like to think we’re at least a little better than that. It would also be horrendously expensive. A cruise missile costs about £500,000. Compare this to the cost of a small boat with an outboard motor and a few AK-47s. Military force would be even more horrendously uneconomic than building a government.

Cheap Not Cheap

The third option may well be the best. It’s a little like the first option, but with a bit of Terry Pratchett added in. Given the government’s are failures and the immorality (not to mention cost) of bombing Somalia into submission, why not go for a more market-capitalist solution and back the pirates? Find some pirate leaders we can work with and offer them a carrot and stick approach. Western governments could turn a blind eye to their activities but attack smaller pirate groups and rogues. This would encourage the consolidation of pirates into larger groups with more organisation and leaders. This is a situation we could work with. Big pirate groups could be played off against each other. With careful support and nurturing and maybe the odd knife in the back we could create one overarching pirate organisation. A kind of Guild of Pirates.

That may sound like a horrendous idea, but it’s not. After all, what is a government but an organisation with a monopoly on the use of force? We’d have finally created a government in Somalia. This organisation could improve the lives of normal Somalis. Their organisation would require infrastructure, provide courts and raise revenue by taxing (extorting) the actual pirates. Now, I admit I’m not 100% sure that this would solve the problem of piracy, but it would probably improve the lives of individual Somalis. When it comes down to it, Somali pirates don’t actually tend to kill people, they just cost us money. Considering the colonial legacy the Western world left Somalia with and the way our fishing vessels continue to deplete their waters of fish it’s the least we could do for them. Our own costs could be reduced by a lower naval presence and the ability to buy ‘insurance’ direct from the pirates.

Ok, I accept that helping pirates to get more organised is not going to be a popular strategy unless it also helped eliminate them. So, it’s worth remembering, organised pirates are much much easier to negotiate with (and to threaten). Their leaders with much more to lose, there are locations that are actually worth targeting and people capable of following through on agreements.

In the end the pirates are, as far as I can see, basically capitalists and in this world of free-market economic orthodoxy perhaps it would be appropriate to back them over the irrelevant* or the ideologues.** It’s not like Western governments don’t have a long history of working with thoroughly unpleasant people to protect ‘capitalism’.

Complaints about the opening of new Tesco stores seem to be quite common. In Bristol the issue even seems to have triggered riots. Complaints generally focus on the destruction of the character of local high streets, producing clone towns. I have a lot of sympathy for this, I don’t particularly like seeing identikit high streets all around the country. Once a Tescos moves in the local butcher, baker, grocer etc all go bankrupt and a part of England’s culture dies, the local community suffers and everyone is very sad.

The thing is though, in the end the majority get what they want in the free market. It’s actually really very democratic. No one forces people to go and shop at Tescos, the Competition Commission (hopefully) makes sure that the supermarket isn’t engaging in market abuse to get an unfair advantage. It’s simply cheaper than most small shops. If people continue to shop in the small local shops then they don’t shut down, regardless of the presence of a new supermarket. The problem is that many of the people who are moaning about the supermarkets still go and shop in them. They do, after all, provide lower prices and much greater convenience. They succeed because people want to buy from them.

I find it quite sad that people choose to shop almost exclusively in supermarkets. The thing is though, that taking legal action to prevent supermarkets from being able to open and compete is effectively asking the majority of people, who would take advantage of the many advantages supermarkets bring, to subsidise your own consumption habits. I don’t see why the majority should be inconvenienced and pay more so that a minority can get a feel good factor. This is even more true if you consider that the greatest beneficiaries of cheap food in supermarkets are likely to be the poor and those most concerned with ‘save our high street’ campaigns are generally a bit more middle class.

I don’t much like supermarkets’ dominance but I shop in them and don’t expect people to pay more for my food so that I can feel good about my high street. So I can’t complain. That being said, if someone would open a half decent bakery in my area, you would totally have my patronage, even with higher costs. If the claims of campaigners were true, then small shops would have no problem competing against supermarkets.

The OECD just released a report on families and child poverty. The Economist highlighted one area which should be of concern to everyone in the UK. At present we spend the third highest proportion of GDP in the OECD on family benefits. Child poverty has indeed fallen as a result of this. However, UK child poverty remains high by international standards and in terms of value for money spent we perform very badly. Despite this, much of the outcry about inequality in recent times seems to have been focussed around two things: benefits cuts and tuition fees.

Undeniably education plays a huge role in both inequality and social mobility. The thing is, university education is not the problem. If you really care about reducing poverty and inequality, the key is early years education. The earlier the better in fact.

There is a significant correlation between test scores at 22 and 42 months and a child’s eventual A level results. There is also a gap in performance between children from different socio-economic groups at only 22 months and this gap increases considerably with age.* The OECD report highlighted that UK childcare costs are more than double the OECD average and that single parent employment is the second lowest in the OECD. If we are really serious about reducing child poverty and increasing educational equality then childcare and nursery education are what we should be worrying about. The two main reasons are explained below.

The Benefits TrapAt the moment a single parent going from government benefits to work faces a very high effective marginal tax rate. Since they lose benefits as they earn more money, they actually get very little gain from increasing their income. If this is combined with high childcare costs, they could well end up considerably worse off financially simply because they started working. Reducing or eliminating childcare and nursery costs will help to deal with this problem. More single parents working means less taxpayer money spent on benefits, a bigger economy and fewer children living in poverty. Reducing child poverty is a worthwhile goal in and of itself, but it also has significant knock on effects on educational outcomes.

Early Education:
If educational inequality is solidified at an early age then it’s important to deal with it as early as possible. Dealing with the UK’s problems of overpriced childcare and lack of affordable nursery provision will help to match the opportunities of the poorest children with those from better off backgrounds. If you can get childrens’ achievement up in their earlier years then you are well on your way to reducing later educational inequality. So, we need better funding for pre-school education.

What’s actually happening?

Surprisingly, despite the austerity measures, government policy looks pretty good in this area. Child benefit cuts made the headlines, but as far as I am concerned, in cutting a universal benefit for better off families is no big deal (in terms of poverty reduction anyway). What does leap out at me is the government’s Fairness Premium. This aims to reduce inequality in schooling through two measures. One is to give schools extra money for taking disadvantaged children (pupil premium), this is very worthy but only peripherally related to this blog post. The other is to give disadvantaged two year olds 15 free hours a week of pre-school education. Spot on! While the government could do more, it is still exactly the right move for it to make.

*Danger Partisan Moment*
For the people complaining that the Lib Dems have abandoned equality with their about-turn on tuition fees, I would take the fairness premium over tuition fees in a coalition agreement any day. This is an area where the government can deliver real change in the fight against inequality and the Lib Dems should be applauded for getting it into the coalition agreement.

NB:
If anyone is interested, the government’s main strategy document on Child Poverty can be found here.

*Pre-School Educational Inequality? British Children in the 1970 Cohort, Leon Feinstein (1998)

I’ve always had a bit of thing for competition policy (yes I know, I’m a geek) and obtaining iTunes has inspired me to write a bit about it. More specifically tying and bundling. Bundling is when two products are sold together while tying describes a situation in which one product can be bought separately but the other cannot be bought without buying both. In the case of iTunes I was caught by a tying situation. You can get iTunes on its own, but you can’t get an iPod without having iTunes.

Competition policy is essentially about consumer protection and aims to prevent businesses from taking advantage of consumers. Or at least as much as is possible while maintaining a balance with the need to provide a good business environment. Tying and bundling can be problematic when a business uses a dominant position in one market (MP3 players in the case of Apple) to then lever themselves into a stronger position in another market. This can give them an unfair advantage over other businesses and may give them the opportunity to abuse their dominant position. Continuing with the example of Apple, I was quite happy using Windows Media Player before, but since my new iPod requires me to use iTunes I’ve had to switch to that. For most people the inconvenience of using two different media players would outweigh any annoyance at having to switch everything over and so the original provider is cut out of the market. A lack of competition is bad for consumers because it reduces the incentive to innovate and opens the market up to abuse from the dominant business.

The classic example of bundling is Microsoft, using Windows. First with Internet Explorer and later with Windows Media Player. By bundling these programs with Windows, Microsoft was able to use Windows’ massive market share to extend their dominance into other markets. It might be hard to remember these days, but if you go back 6 or 7 years Internet Explorer was basically the only browser people used and that was as a direct result of it being packaged with Windows. The Microsoft case is also worth remembering because of the massive penalties imposed on it by competition authorities (€497 million in 2003 by the European Commission).

However, it’s important to remember that tying and bundling are not necessarily bad. Depending on the circumstances they can be harmless, or even quite sensible. The European Commission’s guidance on tying/bundling provides a useful illustration of how such activities can be judged. Essentially four things would be considered. The first of these is whether the business is dominant in the relevant market – a business that does not have market dominance is not going to be able to get an unfair advantage. Secondly, the products involved should be distinct from each other. In other words, if they were available separately consumers might well buy one or the other. Preventing businesses from selling very closely related products together would be rather unfair. Thirdly, there need to be foreclosure effects. This means consumers being shifted away from other products by the tying or bundling. If there are no foreclosure effects then it means that whatever the business might be trying to do, they certainly aren’t succeeding at market abuse. Finally, the Commission also considers whether there are any efficiency justifications for the tying/bundling.

Incentives, perhaps best illustrated through bonuses seem to be a big thing at the moment. Essentially the argument goes, if you want people to work hard and be successful then you need to give them a reason for all that effort and the only way to do that is to give them lots of money. This is a pretty popular argument against any move to a more socialist, or even communist, economic system. There are others of course, but I find this one particularly interesting so it’s what I’m going to talk about.

Fundamentally it assumes that doing work is costly, as is acquiring all of the skills/training that are necessary to be a highly productive worker. Therefore there needs to be some compensation for educating/training yourself and working hard because otherwise you would be better off not working, or doing the bare minimum (depending on how much the state will support you). I think it’s pretty fair to say that working is costly. A few lucky people might get to do highly fulfilling jobs that they would do as a hobby if they weren’t being paid, but for most of us even if we generally enjoy work it will still be a bit of a grind and we would almost certainly like to work less, all other things being equal. I’m a little more dubious about the need for incentives to educate yourself, but I won’t go into that this time.

So, if we need incentives to work, are capitalists right? Are high wages, inequality and such the only way to ensure a successful economy? I’m a little dubious. I’ll happily admit that some kind of incentive is necessary, where I’m not sure that the capitalist argument holds up is in the nature or size of that necessary incentive.

Are monetary rewards the only workable incentives? To answer that question, we need to establish why we want money in the first place. Past a certain (relatively low) point all of our material needs are dealt with. Your average worker in the Western world lives in reasonable comfort, never goes hungry etc. So, larger amounts of money have utility because they give us pleasure, rather than being in any way necessary to our survival. Why does having more money give us pleasure? It certainly makes our lives more comfortable, and fair enough, I can’t deny the appeal of having a large Mercedes and swish flat.

But (and this is a big but), there is a lot of evidence out there that the amount of pleasure gained from wealth actually depends on relative rather than absolute wealth. So, our theoretical high earner would (secretly) prefer a situation where he earned £100,000 p.a. than £200,000 p.a. so long as everyone else earned £10,000 p.a. instead of £40,000 p.a. What does this tell me? Well, on the one hand it suggests maybe increasing inequality is necessary to get the most out of people. On the other hand though, it also suggests that being able to feel superior to your neighbours is actually more important than money. So, perhaps we could work to close the income gap without deincentivising our best workers. In the USSR they had a concept called ‘socialist emulation’ through which individuals and factories would compete to perform best. Results would be compared and the winners would be rewarded. Some rewards were material, but a large part of the reward structure was quite simply prestige and fame.

So, maybe what we need to do is cut the pay that’s going to our most skilled workers but increase the amount of recognition they receive? Maybe company offices should have large pictures of their senior management projected onto their external walls and local papers should run stories about that lawyer who managed to bill 26 hours in a single day?* It doesn’t quite have the ring of Aleksei Stakhanov mining 102 tons of coal in under 6 hours, but if it could reduce income inequality, well… Maybe we should consider it.

More seriously, I am unconvinced that we need to be paying people at the top end quite as much as we do. The pay gap between the top and the average in, for example, Germany is much smaller than in the UK and as far as I can see they don’t have a lack of scientists, decent CEOs etc. Just because you accept the need for incentives to work doesn’t mean that you should support growing levels of pay inequality.

I will finish with this thought though. If you’re getting your money from being paid, however well paid you might be, it’s unlikely that you are one of the truly rich. Real inequality comes from unearned wealth.